Breaking even
Your breakeven sales point, where your total sales cover your COGS and overheads exactly, can also be calculated from your budget.
For example, if your COGS are $500,000 and your overhead costs are $500,000, your breakeven sales point is $1,000,000. However, at this point, you will earn zero profit. Once you sell more than $1,000,000 you will start to earn a profit that is proportionate to your COGS, overheads and net profit margin.
Setting net profit margins
The net profit margin is the one variable you, as the business owner/manager, must set; it is not determined by your internal cost structure. A good target is 10 to 15 per cent. In all likelihood, if you plan a net profit margin between 10 and 15 per cent, you will perhaps make less due to uncontrollable variables such as weather and/or mistakes. Even though basing your pricing on ‘what the market will bear’ is strongly discouraged (as previously discussed), you may need to consider this method when determining your company’s profit margins. However, you cannot do this until your internal cost structure, COGS, overheads and breakeven sales point have been determined.
Job costing tools
Assuming you are consistent year-over-year in terms of your percentage markup for each type of service/work your company offers (i.e. retail, service, new installations, etc.), you can use the exact ratios calculated from your budget to do job costing.
The easiest part of pricing is usually material take off (the materials required to do the job such as concrete, re-bar, pumps, filters, etc.) Most business owners are consistently within plus/minus of one per cent on the required job materials calculation. The challenge is actually determining the amount of labour hours required to complete the job.
If job costing (tracking) is performed properly, after a year or so, you will start to get a feel for the amount of labour hours required to complete a project. Costs for equipment (both owned and rented) and subcontractors are relatively easy to estimate. These constitute the job costs or COGS.
To this value, calculate your overhead recovery amount as a percentage of COGS, and then calculate your breakeven point (the point at which you earn a zero profit). Once this amount is known, you can apply the net profit margin you would like to earn on the project based on factors such as time of year, current workload and/or a competing bid on the job.
To determine the final selling price, use the following formula:
Sell price ($) = Breakeven ($)
——————–
(1 – Profit Margin*)
(*the profit margin is expressed as a decimal [e.g. 10 per cent would be expressed as 0.1]).
